U.K. Ponders Sales Tax Question

As the U.K.’s economic recovery shows growing signs of grinding to a halt, the opposition Labour Party has made increasingly fervent calls for a temporary cut to the sales tax.

With each disappointing piece of economic data—be it subdued retail sales or the upward march of the rate of inflation—Labour’s economic team, led by Shadow Chancellor Ed Balls, have reiterated the line that what the U.K. urgently needs is for Value Added Tax (VAT) to be reduced.

The coalition government, says Labour, made a grave mistake when it increased VAT to 20% from 17.5% at the beginning of the year, and reversing the increase will give Britons a much needed boost—going so far as to say it will put £450 back into the pocket of each family.

Such an amount would help hard-pressed Britons currently being squeezed both by inflation and stagnant wage growth.

On Friday, Angela Eagle, Labour’s Shadow Chief Secretary to the Treasury, reacted to the GDP figures which confirmed that the U.K. had only grown by 0.2% in the second quarter.

“[Chancellor] George Osborne’s reckless and incautious decision to cut too far and too fast has undermined our recovery well before the recent problems in the euro zone and America, leaving us dangerously exposed if things now go wrong there,” Ms. Eagle said.

“We need an emergency temporary VAT cut to get the recovery back on track and ease the squeeze on families, and Labour has called for a bank bonus tax to fund 100,000 jobs for young people and more investment in regional growth.”

Labour is not alone. The British Beer & Pub Association, the trade body for the U.K.’s brewing and pub sector, is calling for VAT on restaurant food and hotel accommodation to be cut.

Trade publication The Publican’s Morning Advertiser has organised a petition, supported by celebrity chef Marco Pierre White, for VAT to be slashed to 5% across the hospitality sector.

But is there any evidence that a cut in VAT will have the desired effect and stimulate the economy? The answer is no, according to analysis from Capital Economics’ U.K. economist Samuel Tombs.

The U.K.’s hospitality sector has used France, which cut VAT on restaurant food to 5.5% in 2009, as an example of how a lower rate of sales tax can boost the sector and save jobs.

But Mr. Tombs says the evidence from France—as well as from Finland, Germany and Ireland, which have also cut VAT on parts of their hospitality sectors—is that the cuts have been “relatively impotent”.

Evidence from the countries suggests that firms only passed on a small fraction of the tax cut to consumers, and that there has been no clear pattern of increased job creation.

While there was an increase in activity in the French restaurant sector and the German hospitality sector after the cuts were introduced, Mr. Tombs says the increases coincided with a general improvement in consumer confidence at the time.

“What’s more, these increases may have simply been at the expense of spending on other consumer goods,” he says.

“As a result, there is little to suggest that the direct costs of overseas VAT cuts have been recovered through the positive effects on output or employment.”

Of course, the U.K. itself has also experimented with cutting VAT to bolster demand.

At the height of the financial crisis in December 2008 the previous Labour government cut VAT to 15% from 17.5%. Mr. Tombs claims the cut had little beneficial effect on prices and demand remained sluggish.

While the call to cut VAT is a handy soundbite for Labour to use—and one that is likely to resound with consumers—economists say it may be too blunt an instrument to be the one-size-fits-all remedy the party is using it as.

The time may have come for Labour to look for a ‘Plan B’ to use as its economic rescue strategy.

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